Q4 2020: Year in Review

Where to begin in a review of 2020? A global pandemic. An oil price collapse. An impeachment trial. A market crash. Wildfires on the West Coast. Floods on the East Coast. Lockdowns. Mass unemployment. Olympic Games postponed. Nationwide civil-rights protests. A contested election. Even murder hornets. One could be forgiven for expecting an investment review would bring similar grim news. Yet 2020 somehow offered investors with solid returns: last year, global stocks rose more than 16% and global bonds were up over 6.5%, well above their historical averages.¹

Along the way, 2020 provided investors with two very big, very scary situations. First was COVID-19. COVID began the year as a faraway danger, became a growing concern and, finally, morphed into a full-blown global pandemic shutting down large swaths of economies worldwide. The subsequent crash was swift and brutal: global stocks dropped more than 30% in six weeks. But those who stood their ground or rebalanced toward equities were soon rewarded as stocks returned to their pre-pandemic highs within six months.

As stocks recovered, however, the prospect of a contested US presidential election loomed large in investors’ minds. Many investors, regardless of their politics, feared we would see civil unrest and political violence. Some even considered getting out of the market altogether. Unfortunately, we did have a contested election and the subsequent unrest and violence. Fortunately for investors, however, stocks went up around the world. Most equity indexes rose double digits during 2020’s final quarter, richly rewarding those who stayed the course.

Although most everything went up last year, investors saw large differences within equity returns. Both US and emerging-market stocks jumped over 18%, while developed-markets stocks rose just under 8%.² Most notable, however, was the contrast between growth and value stocks, especially in the US. Domestically, value stocks rose a modest 4% while growth stocks leaped nearly 35%.³ Further, as we discussed after Q2 2020, the growth returns were largely driven by 5 very large, seemingly “COVID-proof” companies.⁴

Last year was the fourth in a row in which growth topped value. Growth stocks have risen so much recently that it feels like growth has dominated value for a long time. As you may know, we typically recommend a mix of growth and value equity in our client portfolios. Value’s relative returns, along with the continuing upswing in a handful of big-name companies, prompted some investors to question whether it still makes sense to invest in value.

Today we will review the recent returns for growth and value. We will show that growth’s meteoric rise is a short-term phenomenon and why we believe it remains prudent to hold both growth and value in long-term portfolios.

A casual observer reviewing the trailing returns of domestic stocks might find little appealing in a value-based strategy. The chart below shows the returns for large-growth US stocks (the Russell 1000 Growth Index) and US large-value stocks (the Russell 1000 Value Index). We have included the S&P 500 index, representing the broad US stock market, for comparison:

Indeed, we see a very large difference between value and growth returns. Value stocks went up over the last 10 years, rising over 170%. Growth’s return, however, dwarfed value as growthy stocks rose just under 390% over the same time. At first blush, it appears growth stocks dominated the 2010s.

A closer look, however, reveals a very different picture. What we see over the last decade is two materially different patterns. Looking at the next chart below we see, 6 years into the last decade, growth and value provided total returns within 2% of each other – meaning nearly identical annualized returns (10.6% and 10.4%, respectively).⁵

Moreover, value stocks rose significantly following the 2016 election. From election day through the end of the calendar year value stocks went up about 7.5% compared to 2.8% for growth stocks. At the time, analysts and investors expected the Trump presidency, through lower taxes and fewer regulations, would likely be good for equities, and especially value. Safe to say, actual events did not live up to market expectations. Instead, we saw a huge divergence – with growth beating value – each year every year over the last four.

This chart shows the last four years, in which we see a historically large growth rally:

Many investors have drifted away from value companies due to the recent “subpar” returns. But are value returns truly subpar? Over the last four years, value stocks have risen more than 35%, for an annualized return of just under 8%. In today’s low inflation environment, an 8% return is roughly consistent with long-term equity returns. Value’s return, thus, only feels low when we compare it to growth. During that same time, growth stocks skyrocketed 142%, an annualized return of nearly 25% (!), far more than their long-term average.

We’ve recently seen some growth-stock advocates argue something to the effect of “why invest in value at all if half the time it’s tied with growth and the other half it loses badly?” A slightly longer historical view provides the answer: If we look at the 10 years ending December 2010, we get a very different picture:

From 2001 through 2010, value stocks rose almost 38%. Growth stocks, however, provided essentially no return. This is why we believe a mix of growth and value remains prudent: investing for an entire decade with zero return can negatively impact the confidence of our financial plans. Moreover, waiting 10 years for any return whatsoever is very hard!

Indeed at that time, common wisdom maintained investors should stay away from large-growth US companies. In hindsight, we understand that advice was completely wrong. But we forget how fraught that time was. We had just ended what was known as the “Lost Decade” for the S&P 500 because US large-cap stocks had a negative 10-year annualized return.⁶  And the following year, 2011, brought us the US Debt Ceiling crisis and an unprecedented potential default on US treasury debt. Back then, the ostensible “smart money” advised investors to eschew stocks in developed countries, and instead focus on emerging-markets stocks and alternatives such as commodities, currency, or hedge funds.⁷ Despite such industry pressures, we maintained our long-term strategic allocation to growth stocks. And we’re very glad we did.

We feel it’s safe to say that no one saw the events of 2020 coming. As people, we are fortunate to have survived the year. As investors, we are fortunate to have weathered two massive, frightening events with our portfolios intact. During periods of extreme stress, we tend to hunker down and focus on the now. Doing so can be a boon to our physical and mental health: it’s important for us to care for ourselves and others today, regardless of what tomorrow brings.

But a short-term focus may not help us as investors. We strongly caution against the (natural) feeling that things will continue on their current track. The truth is we don’t know what the future will bring. History suggests the next five years are unlikely to be the same as the last five, either in our lives or the capital markets. Thus, we continue to recommend a globally diversified portfolio, with a mixture of growth and value, to help ensure we get our fair share of whatever comes our way.

Copyright © 2021 Wealth Architects, LLC

¹ Global stocks represented by the MSCI ACWI Index. Global bonds represented by the FTSE WGBI 1-5 Index (unhedged). Source for all investment returns unless otherwise noted: Morningstar. Past performance is no guarantee of future results.

² US stocks represented by the S&P 500 Index. Developed-markets stocks represented by the MSCI EAFE Index (Net). Emerging-markets stocks represented by the MSCI EM Index (Net).

³ Value and growth stocks represented by the Russell 1000 Value and Growth indices, respectively.

⁴ See Q2 2020: Lonely at the Top, Wealth Architects, July 2020.

⁵ Sources for all annualized return calculations: Morningstar and Wealth Architects.

⁶ See, e.g., A Tale of Two Decades: Lessons for Long-Term Investors, DFA, February 3, 2020.

⁷ See, e.g., What “New Normal?” El-Erian’s PIMCO Fund Falls Flat, Goldberg, Investing.com, November 20, 2013.